Investment commentary June 2016

Quick overview

Interest rates will probably rise in the US in the near term and this might cause volatility to rise

The RBA has a challenging task of stimulating inflation without overheating the property market

Unlikely outcomes in politics could have unpredictable effects on markets

Shares running out of puff

Share markets rebounded strongly from their rocky start to the year, with Australian and international equities up 15% from their mid-February lows. At these levels though some markets are looking a bit expensive, and the outlook for earnings seems quite challenging.

Analysts expect Australian shares to grow earnings by 10% in calendar year 2017, which would be a strong result and which will rely heavily on a recovery from the resources and energy sectors. If these optimistic forecasts are not met then investors might be less willing to support these high valuations, and markets could reprice lower.

All eyes are on the Fed

Economic indicators in the US are reflecting an environment of steady growth and core inflation trending back to normal. The “will they, won’t they” debates about whether or not the Federal Reserve will raise interest rates continue to drive markets and officials’ speeches are combed for hints one way or the other. While the committee remained on hold in June and may also do so in July, it is still likely that rates will rise at least once more in 2016. This shouldn’t really be a surprise to markets but it’s such an influential measure that even a widely expected change might still cause volatility to rise.

RBA in a quandary

Back home our central bank cut rates to 1.75% in May, responding to the weakest core inflation reading since 1999. The markets quickly moved to price in another cut before year end. The RBA needs to tread carefully though. The overall economy is actually growing at a healthy pace of 3%, unemployment is low and the housing market is booming. Their mandate is to promote price stability which suggests they should continue to cut rates until inflation improves, but they’ll be carefully weighing up the risks of creating asset bubbles which could create problems down the track.

Political ‘Black Swans’

While the results of the Australian election are unlikely to faze markets, there are two other political campaigns underway which could have wide reaching effects.
The first is a referendum in late June to decide whether or not Britain will remain in the European Union (colloquially known as Brexit).

The second is the US election where a Trump presidency which seemed like an outlandish possibility 12 months ago is now priced at a 25% chance on betting markets.
It’s more likely that Britain will remain in the EU and that Clinton will beat Trump, but an upset in either event could make for interesting times.